Much has been written about retirement planning and the right mix of stocks and bonds as you get older. Recently, a client forwarded a New York Times article to me that was written by David A. Levine, former Chief Economist at Sanford C. Bernstein & Co. The two-part article sought to challenge the longstanding advice that as investors get older they should reduce their exposure to stocks.
The author went as far as to suggest that investors of all ages should maintain a 100% allocation to stocks. His reasoning for this bold recommendation, although tough to follow, seems to be based on the idea that over a long enough time horizon the average performance of stocks will outperform the average performance of bonds. He also goes on to say that Warren Buffett suggests a 90% allocation to stocks.
The Fallacy of Averages
Whenever "investment experts" talk about averages, I am always reminded of the economics joke about putting your head in the freezer and your feet in a fire and coming out with an average body temperature. Averages can produce misleading and often deceptive data, particularly if you look at the simple arithmetic average. In your portfolio, that would be the total of your annual returns divided by the number of years being measured.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Let's look at an example: Suppose, in 2004, you were a 65-year-old new retiree with $100,000 in an individual retirement account. Your plan was to withdraw $4,000 per year to supplement your Social Security and other retirement income. In the four years preceding the Great Recession of 2008, Standard & Poor's 500-stock index returned 10.7%, 4.8%, 15.6% and 5.5% respectively. Then in 2008, the market dropped by 36.6%. The average performance over that five-year period was 0.02%. But by the end of 2008, your remaining IRA balance would have been just $74,268. And that does not include any fees, taxes or inflation during that period.
A skeptical reader might suggest that 2008's market decline was atypical. However, keep in mind that since 1928, the S&P 500 has declined 20 times by 20% or more. That's once every 4.4 years.
And in terms of Warren Buffett's advice, I refer you to this quote from him: "Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market."
Why the Longstanding Advice Makes Sense
In retirement, your portfolio management decisions require a mindset shift. The reason you reduce your allocation to stocks and increase your allocation to bonds is because capital preservation, more consistent performance (i.e., less volatility) and fewer significant drawdowns are more important objectives than growth.
Rather than trying to beat an index, we recommend that you target an after-tax performance range between the inflation rate on the low end and your withdrawal rate on the high end. This can help you maintain your purchasing power and preserve your principal balance whenever possible. Using the example above and an inflation rate of 2%, the target range would be between 2% and 4%. Even in this low-interest-rate environment, you can construct a relatively conservative, predominately fixed income portfolio to help meet that performance goal.
The Retirement Time Horizon
The clients we meet with have plenty of financial issues to consider without adding stock market volatility to their list. Retirees today are less likely to have pension income, are facing rising healthcare costs and are living longer than ever before.
To maintain the lifestyle that they have come to expect, retirees need a high degree of certainty built into their portfolios. With stocks trading at high valuation levels and interest rates at historic lows, we have shifted many of our clients away from equity and bond funds and into individual investment-grade corporate or municipal bonds. These bonds provide semi-annual interest payments and give clients the ability to hold their investments until maturity without having to worry about daily price fluctuations. To protect against rising interest rates and increases in inflation, we stagger the maturities of the bonds (bond laddering) so that proceeds from maturing bonds can be reinvested at the then higher interest rates.
When you are young and have years of compounding returns ahead of you, taking equity risk can make good sense. As you enter retirement, you simply cannot afford the risks of a 2008-like decline.
Note: The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income.
This article is intended for informational/educational purposes only and should not be construed asinvestment advice, a solicitation, or a recommendation to buy or sell any security or investment product.Please contact your financial professional for more information specific to your situation.
Bryan Koslow, MBA, CFP®, CPA, PFS, CDFA™ is the President of Clarus Financial Inc., an Integrated Wealth Management firm with offices in NYC & NJ.
Securities and advisory services offered through Commonwealth Financial Network®, Memberwww.finra.org / www.sipc.org, a Registered Investment Adviser. Clarus Financial Inc., 120 Wood Ave South, Suite 600, Iselin, NJ 08830. 732-325-0456. Please review our Terms of Use.
-
What Dave Ramsey and Caleb Hammer Taught Me About Handling MoneyFrom Ramsey’s strict discipline to Hammer’s blunt reality checks, their lessons reveal how to save, invest and prepare for the future.
-
Dismal August Jobs Report Offers Rate-Cut Relief: What the Experts Are SayingThe August jobs report came in much lower than expected, lifting the odds that several rate cuts will come through by year's end.
-
Greed, Fear and Market Volatility: A Financial Adviser's Guide to Keeping Emotions Out of Investment DecisionsDon't panic! And don't be so confident in the stock market that you overlook risk. Instead, be logical. Your retirement security could depend on it.
-
Want a Financial Adviser Who Shares Your Faith? Look for One With a CKA DesignationFinancial professionals with a Certified Kingdom Advisor certification are committed to integrating biblical principles with sound financial advice.
-
10 Ways to Stay Safe From Grandparent Scams and Other Fraud, Courtesy of a Financial PlannerScams are increasingly hard to detect, and anyone can be fooled, from older people to educated professionals. Here are 10 ways to avoid becoming a victim.
-
This Is How the Student Loan Bubble Is Primed to Pop, From a Student Funding ExpertFueled by easy money, inflated tuition and high default rates, the student loan bubble mirrors the 2008 subprime mortgage crisis. We could be headed for a potential financial collapse. What can we do?
-
More Than Money: The Hidden Toll of Financial Abuse of Older AdultsFinancial abuse from schemes involving tech support, government impostors, false sweepstakes, grandchild hoaxes and online shopping issues can cause thousands of dollars in losses.
-
I'm a Financial Planner: Here Are Three High-Impact Ways to Make a Difference With Your DollarsThe world often feels out of control, but here are three ways to use your money — through investments, charitable giving and political donations — to help create a more just and sustainable future.
-
The Unsung Hero of Aisle 5: A Tale of Forgotten Change and Compassion at the SupermarketThis supermarket manager went above and beyond to help when a child forgot her change at the checkout counter. You might be surprised at some of the complications that supermarkets face when it comes to customers' forgotten change.
-
Train, Integrate, Retain: A Strategic Playbook for Adviser OnboardingsBuild a thriving practice by training new advisers with clear goals, structured processes and consistent mentorship for strong team growth.
